The ten-year deal will see Yahoo sell search ads under Microsoft’s fledgling Bing brand.
No upfront payments have been made between the two companies but they have agreed a dynamic revenue-share model over the first five years.
Yahoo estimates the deal will bring in an extra $500m (£300m) for the company.
Microsoft CEO Steve Ballmer said, “Success in search requires both innovation and scale. With Bing we’ve created breakthrough innovation and features. This agreement with Yahoo will provide the scale we need to deliver even more rapid advances in relevancy and usefulness. Microsoft and Yahoo know there’s so much more that search could be.”
Yahoo CEO Carol Bartz said, “Users will continue to experience search as a vital part of their Yahoo experiences and will enjoy increased innovation thanks to the scale and resources this deal provides. Advertisers will also benefit from scale and enjoy greater ease of use and efficiencies working with a single platform and sales team for premium advertisers.”
It’s unclear whether the move will see any Yahoo or Microsoft staff made redundant.
A combined Yahoo/Microsoft search offering will create a much stronger challenger to the dominant Google brand. According to ComScore, Microsoft and Yahoo have 8% and 20% of US search share respectively, behind Google’s 65%.
The deal comes 18 months after Microsoft launched a multi-billion-dollar takeover bid for Yahoo.
Yahoo did strike an $800m (£495m) paid-search deal with Google last year, which collapsed in November following pressure from parties including anti-trust investigators and Microsoft.
Bartz is believed to have met Ballmer to discuss a possible search deal soon after joining the company at the start of the year. However, today’s announcement is the first time anything formal has been revealed.
Last week both Yahoo and Microsoft posted online ad revenue declines through the second quarter of 14% and 16% respectively, days after Google revealed its ad revenues were up by 3% over the same period.
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